As month end approaches and monthly positions adjust, central bankers first priority is check money supplies as they are constrained by not month end but the 35 day Maintenance Period instituted by the United States in 1979. The 35 day Maintenance Period then carried over in 2000 to a central bank meeting every 35 days. Forward Guidance as next priority allowed the central banks to inform all is fine and the news conference validates the various economic scenarios. As money supplies are released at month end for the previous month, central banks are governed by trader month end to the 35 day period.
Prior to the build in stimulus and money supply concentrations by central banks, overnight rates free floated as market determinations rather than the new tool to hold overnight rates in tiny ranges. A bank in deficit at end of day had to buy currency to balance while a surplus bank sold currency. The overall supply of bank money at day’s end determined if the overnight rate reported higher or lower and in turn affected other market interest rates. Interest rates and money supplies back then as today held an adverse relationship. By week’s end, the central bank then added or subtracted monies to maintain a balanced money system.
Under stimulus, the system shifted as the overnight rate was controlled by volume weighted medians rather allow a free float and this allowed the central banks to multiply and have their way with stimulus. The overnight rate was separated from stimulus. If the main overnight interest rate is controlled then all interest rates associated with the overnight rate is controlled as one interest rate affects another. The methodology is hold interest rates in tiny corridors so to never allow the system to crash or spiral out of control while stimulus is employed to purchase bonds.
Fed funds closed at 1.16 in 37 of the past 38 days and 79 of the past 81 days since June 2017. What explains the 2 lost days is Fed Funds traditionally takes a dive 1 or 2 days every month and closes lower, 1.06 and 1.07 since June.
Europe’s Eonia in the same time frame traded 0.63 to 0.65. USD money supply at M2 in June 2017 was 13, 548.9 billion and sits in September at 13,694.2 billion, a 145 billion rise in 3 months. European M3 went from June at 11,650 billion to August at 11,743, a 93 billion rise. Despite the money supply moves, interest rates remained stasis. If actual balance sheets were factored and interest rates properly adjusted then current overnight rates would be located at far lower rates.
If 1.16% is factored to 13,694.2 then M2 should be 15,885.2 to minus 15,885.2 and Europe’s M3 should be 7632.95.
The money supply/ interest rate relationship experienced money velocity to dive on a straight line trend downward as the relationship is out of kilter. USD M2 money velocity in Q2 2008 went from a high at 1.92 to 1.73 in Q1 2009 to current 1.42. European M3 growth rates on a seasonally adjusted basis flat lined since 2014 when the ECB went negative.
If velocity dives it means GDP is out of sync to M2 as velocity answers how often does the currency in use purchase goods within a time period. Velocity should travel higher when an economy is on a growth track but this is seen when money supplies decrease. Europe’s economy recovery is inside a 50 – 50 shot.
Velocity validates the progression money supply, interest rates, exchange rates, other financial instruments then price indicators in GDP and Inflation. If money supplies rise then interest and exchange rates drop as well as GDP and Inflation. What is solidified is the overall market indicator price relationships. GDP in the United States for the past 8 years is reported by the Office of Management and Budget as an average at 1.9%. GDP grew 2.1 trillion from 14.4 trillion to 16.5 but debt and money grew far faster.
The easy aspect to money supplies as an indicator are overbought/ oversold issues while far more in depth issues exist to Capital Ratios, supply to steer money to loans, Repo and interest rate markets and questions to paying interest on excess reserves and Reserve Ratios.
Market interest rates free floated before stimulus because Reserve Ratios targeted the short term weekly demand by supply of money in M1. Money imbalances to reserves caused a move in Fed funds and this is the Open Market operations aspect to Fed Policy. By today’s control of money supply to meet predictive reserve demand, Reserve Ratios were employed to stabilize money markets and interest rates to prevent fluctuations.
Current January 2017 Reserve Ratios in Net Transaction account liabilities are running 10% and 3%. The 10% and 3% has been fairly standard since the Garn St Germain act in 1982 although the 1990’s experienced a drop from 3% under Willie Clinton. Drop the low end from 3% to 0 then spurs more loan growth as money becomes available and not subject to the penalty tax of reserves ratios.
0 to $15.5 million = 0 requirement
$15.5 million to $115.1 million = 3%. Current threshold amounts and channel is $15.5 to $115.1 million.
Above $115.1 million = 10%. Current threshold amounts and channel is $15.5 to $115.1 million due to the lower 3% liability. The questions to 10% and 3% are amounts to the low side of 3%. The current 0 to $15.5 million is the result of Garn St Germain as the first $2 million was exempted from liability consideration. The adjustment amount exempted as reported by the Fed is factored “upwards as 80% of the previous years rate of increase in total reserve liabilities”. If no increase then no adjustment to exemptions as was seen from Dec 1988 to Dec 1990 and Dec 2009 to Dec 2010.
In January 2009, the low sides were $10.3 million exempted to $44.4. In January 1984 at the start of Garn St Germain, the low sides were $2.2 million exempted to $28.9 million. Since 1983 the low side experienced a continuous rise in money amounts as well as exemptions. Overall, current Reserve Ratios are 0 to 10%.
From 1984’s lows at $28.9 million, it took 27 years to Dec 2010 to see $58.8 million and 2 times the amount from $28.9. The exemption from $2.2 doubled to $4.4 in 1996 and in 12 years time. Then $4.4 million doubled to $8.8 million in 2006 to 2007 and 10 years time. Since the $8.8 million in 2006 to 2007 and at the current $15.5 exemption, its been 10 to 11 years and the next double comes at $17.6 million. From Fed Funds at 1.16 and factored to $15.5 and $115.1 then the range results to $17.98 million to $133.51.
From 2009, at $44.4 to $10.3 to current $115.1 and $15.5, the $44.4 doubled in 8 years while the exemption rose $5.2 million. In the previous 10 years from 2009 to 1999, the low end ranged from $42.1 to 48.3 while the exemption went from $5 million to $7.8 million. The current period from 2009 to present is the most volatile since 1982 beginnings of Garn St Germain.
As the Reserve Ratio traditionally was viewed as a tax because required reserves failed to earn interest as money sat idle and because Reserve Ratios never moved for or against interest rates, the current 1.25% payed on excess reserves became the premiere indicator since 2008 as it moves alongside a rise or fall in headline interest rates. Excess reserve interest became the money and overall interest rate channel and replaced the reserve ratio as the new monetary policy.
Since 2008, interest paid on excess reserves acted as a floor and ceiling alongside the effective fed funds rate. Current Fed Funds at 1.25 means the floor and ceiling channel flows from 1.0 to 1.25. At 1.25 represents the ceiling while 1.0 acts as the floor and the target range is a standard 25 points. At 1% interest rates, the channel became 0.75 to 1.0.
When interest rates were near 0, the channel was set by the Fed at 10 and 15 points so not to allow a 0 interest rate. Call it a channel or corridor but 25 points is where is seen repos, reverse repos, fed funds trade activity as well as bank money to satisfy reserve requirements. The Feds complete domination of interest rates sets the channel at any rate to their desire.
Since 2008, excess reserves skyrocketed on a straight up trendline. From an economic view, the effects to skyrocket reserves on lending, economic activity and bank loans appears as no effects. Inflation rates since 2008 appear immune from high excess reserves. The money multiplier appears immune as well. Money available to lend by banks doesn’t mean anyone wants a loan. If the Fed again raises then interest on excess reserves will again rise to a higher degree of excess money.
If the interest paid on reserve channel is expanded, much volatility will come to interest rates and all market prices. To maintain or restrict the channel then excess reserves will continue expansion . As long as interest is paid on reserves, excess money will expand.
The concomitant example is Willie Clinton lowered the 3% Reserve Ratio to zero and Fed Funds as well as all interest rates and market prices saw huge volatility. As the 3% threshold was reestablished then markets and interest rates normalized to an acceptable range.
Interest paid on excess reserves is an experiment yet long advocated by the fed dating to Arthur Burns as Chairman of Eisenhower’s Council of Economic Advisors and Fed Chair from 1970 to 1978.
The Fed views the excess reserve channel not from a monthly perspective but from the 35 day maintenance period.
Brian Twomey
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